South Carolina Approves CAT Models, Weighs Building Public Model

South Carolina regulators have approved seven private catastrophe models for use in ratemaking while conducting a legislatively mandated study on the feasibility of constructing a public model.

South Carolina Insurance Commissioner Ray Farmer recently signed-off on the first state-approved models for use by private insurers, which was the result of a two-year process involving regulators, representatives of modeling companies and a team of independent experts.

As a result, starting this past June 1, all property insurers must use one or more of the state-sanctioned seven models when making rate filings. The seven models include three developed by AIR Worldwide Inc., three others by EQECAT, Inc., and one by RMS.

Farmer said the use of the models would give regulators much needed information on the distribution of risk, especially on the state’s coastline.

“Insurance companies are using three or four models and this would give us a greater tool when approving rates regardless of what they are,” said Farmer.

Oyango Snell, state government counsel for the Property Casualty Insurers Association of America (PCI), said the industry had no opposition to the use of the models, especially given the large exposure in the state.

“The models have worked pretty well and have been adequate,” said Snell, who noted that it could only take one storm, say the size of Hugo, to fall outside of the boundaries of the models.

Still Snell said the use of models works in the state’s favor.

“The models are supportive of what South Carolina is trying to do and it will be an improvement,” he said.

The use of models does entail some caveats. Per state law, the insurance department does not accept an insurer’s historic hurricane catastrophe as the sole basis for a rate filing. Regulators, among other things, also do not use the various model variations that include short-term events or factors such as “warm phase,” “warm water,” and “warm sea surface” temperatures.

Catastrophic models that include claims from tropical storms or tropical depressions may only be factored in if they are not included in an insurer’s historical data. This prevents them being doubly counted, both in historical data and any modeling results.

In addition to the state-sanctioned private models, state lawmakers this year asked regulators to explore creating a public model, much in the same vein as in Florida. Specifically, the study must assess the state-specific model’s potential benefits to consumers including whether it would create a more accurate picture of the risk insurers face in South Carolina and how that translates into rates.

Farmer said he expects the department will have completed the study sometime before the end of the year. The South Carolina School of Risk Management is spearheading the study.

The state’s biggest challenge, however, may not be technical, but one of dollars.

Based on Florida’s experience, creating a public model would require a substantial amount of both time and money.

Florida Hurricane Catastrophe Fund Executive Director Jack Nicholson also sits on Florida Commission on Loss Projection Methodology, which approves all models including a public model developed by the Florida International University.

Nicholson said the state has poured millions into creating a public model and continues to do so given the fact that private modelers themselves are always modifying their own models.

“It takes constant maintenance because the models change,” said Nicholson. “It is a constantly evolving process.”

It is a fact not lost to Farmer.

“Certainly it is one factor that we are looking at,” said Farmer. “It’s not just building the model but the cost to maintain it.”

South Carolina Wind and Hail Underwriting Association Executive Smitty Harrison said the SCWHU utilizes a blend of the RMS and AIR models. That way, Harrison says the association has the most accurate modeling results.

“With the blend we are trying to take out the peaks and valleys,” says Harrison, noting that is what drives reinsurance cost and insurance-linked securities.

Harrison has one concern for consumers. For years, coastal policyholders have forcefully argued that they are paying higher rates that in turn subsidize policyholders further inland. Now those coastal policyholders hope the public model will back-up their claims.

Harrison said that the public model might do little to assuage the coastal residents’ concerns.

“Consumers believe the models will lower rates considerably,” said Harrison. “But if you look at Florida, their model is not always the cheapest.”